Canada in the 21st Century Series

No. 1: Global Trends: 1980–2015 and Beyond

by Bradford De Long, University of California, Berkeley, under contract with Industry Canada, 1998

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Summary

Two global forces have dominated the development of the world economy for the past two decades, and promise to dominate the future economic development of the world for at least the next two decades. The first is the increasing integration of the world economy — what is often termed "globalization". The second is the worldwide productivity slowdown that struck the industrial economies in the mid-1970s, and that ended the "Great Keynesian Boom" of the first post-World War 2 generation.

There are additional factors that have also greatly changed the world economy in the past twenty years: growing concerns about ecology; the fall of the Soviet Union; and the extraordinarily rapid industrialization of East Asia. Many others could be named. All have an impact on the future of Canada as well. Yet they all take a secondary place relative to the ongoing integration of the world economy on the one hand, and the global slowdown in aggregate productivity growth on the other.

What might the future bring? What impact will future economic changes have on Canada, a highly-open, resource-rich, wealthy industrialized economy with a strong social democratic tradition?

The best forecasts extrapolate the impact of these two primary factors, because to date at least there are no signs that they have exhausted their force. The growing integration of the world economy is in some respects a very old story, for the world economy has been "globalized" before. In the decades before 1914, indices of international economic integration such as the share of total world economic product shipped across oceans or the proportion of investment directed across national borders were all as high as or higher than they are today. Canada flourished under the pre-World War 1 gold standard during the world economy's last experience with "globalization": capital from abroad financed infrastructure and industry, especially the food- and resource-processing industry; British and European markets were willing to pay high prices for a growing flow of Canada's exports. Pre-World War 1 globalization provided Canada with a golden age of growth.

Today's "globalization" is different in important respects: it is a "high bandwidth" rather than a "low bandwidth" global economy. Before 1914 you could buy foreign securities — but not exercise corporate control across national boundaries. Before 1914 you could import foreign commodities — but not use your own knowledge of production processes and consumer demand to lower the costs and improve the quality of the goods made by your foreign suppliers. Before 1914 you could transmit information with the speed of light — but only the most important pieces of information, not the surrounding context and certainly not the details that today increasingly weld the world into one culture.

Thus new "globalization" will be different from old "globalization"; however, we do not yet know how the differences will matter. Nonetheless, it can safely be forecast that the return of the integrated world economy will see the return of four processes that are very familiar in the context of economic history:

• The decline of macroeconomic autonomy: countries are by and large losing the ability to manage their own macroeconomies to attain domestic goals alone. Highly-open economies like Canada have had relatively limited degrees of macroeconomic autonomy since the end of the 1950s and the return of full currency convertibility around the globe. Even limited autonomy has proved a powerful tool for governments to use to manage their economies. And that limited autonomy is fast shrinking. Increasing integration diminishes the ability of fiscal policy to affect demand for domestic products, and forces monetary policy into the role of avoiding large exchange rate fluctuations.
• The re-appearance of large-scale international capital flows: this makes it possible for countries following prudent economic policies to grow rapidly as they attract international investment (and for countries following imprudent economic policies to stagnate). Canada was a major beneficiary of pre-World War 1 large-scale capital flows (relative to the much smaller world economy of that day). It promises to be a major beneficiary of the future's capital flows as well in the event of a general rise in the prices of natural resources that causes Canada's resource-extraction industries to boom. However, the re-appearance of large-scale international capital flows also increases the frequency and potential destructive consequences of international financial crises.
• The crisis of the world labor movement: the movement faces its greatest historical challenge as industries distributed across countries call for international-scale organizing efforts in the same way that pre-World War 2 industries distributed across provinces called for national-scale organizing efforts. The union movement may or may not meet this challenge: if it does not, or meets it with great difficulty, we can look forward to a future in which the distribution of income is more unequal in industrial countries — but in which the economy may possess greater static efficiency. The Canadian tradition of social democracy is thus likely to come under at least potential threat over the next generation.

The worldwide slowdown in productivity growth that began in the mid-1970s slowed productivity in the industrial core, in Canada as well as in Europe, the United States, and Japan, from an official growth rate of 3 percent a year to about 1 percent per year. It used to take 24 years or so for standards of living in the industrial core of the world economy to double; now it will take some 72 years or more for standards of living to double. Thus perhaps half of the economic growth that the current generation could reasonably have anticipated has vanished.

The causes of this slowdown in productivity growth are still in dispute. Most likely they consist of a number of small, unrelated independent factors.

Even though each of the likely causes is barely noticeable, taken together they have had major consequences. Following are a few examples:

• Semi-stagnant incomes generate distrust of all governments. Politics acquires a nastier edge.
• The age of diminished expectations means the end of the expansion of the social welfare system, and thus the near end of social democracy as a political force.
• Social democratic promises that assumed the continuation of a 3 percent per year productivity growth can no longer be kept.

The first of these effects makes it much more difficult to find solutions to the oncoming fiscal crisis of the social insurance state. The second may well mean the end of what has been the major political movement in industrial democracies for virtually the entire century. And the last of these requires bold and decisive action by the rudderless and distrusted governments of industrial democracies.

Considering the two major trends of globalization and the reverberations of the productivity slowdown that are likely to have the largest impact, and other factors whose importance is difficult to determine at this stage, the second half of this essay briefly sketches three possible scenarios: three futures that might come to be.

In one scenario, East Asia comes to dominate the world economy in short order. In a second, the end of the Cold War and rising inequality lead to the end of the free-trade system. In a third scenario, international financial crises grow in virulence and frequency, and there are larger and more damaging recessions and depressions.

In the first scenario, problems of structural adjustment become urgent as the world economy must adjust to East Asia's pace. The evolution of the old industrial core from manufacturing-centered toward service-export and information-centered economies is accelerating. Yet in recent decades the governments of industrial democracies have not covered themselves with glory in managing the tasks of structural adaptation and labor force reallocation.

In the second scenario, a different set of structural adjustment problems emerge and become urgent. The retreat of the world's economies away from free trade requires a shrinkage of each economy's export industries and an expansion of each country's import-competing industries. National governments must strive to limit the damage done by a declining international division of labor: in the 1920s and 1930s governments facing similar situations by and large failed.

In the third scenario, the long-term health of the world economy hinges on the ability of central banks and finance ministries to work together, and not at cross-purposes, to keep fear of the consequences of future financial crises from limiting investment and economic growth.

Canada in the 21st Century Series